San José, Costa Rica, since 1956

Tax Reforms Approved, Enter Judicial Review

The long-discussed tax reform bill, approved late last week by the Legislative Assembly, has entered the next phase of its path toward becoming a law: review by the Constitutional Chamber of the Supreme Court (Sala IV).

Sala IV justices, at the request of 16 legislators who submitted the bill for their consideration, have 30 working days starting Monday to examine the bill’s constitutionality and make recommendations to the assembly before it goes to a required second vote.

The 143-page request for review, of which The Tico Times has a copy, describes concerns not only regarding the constitutionality of the tax plan’s content, but also about alleged violations of legislative procedure during its discussion. Libertarian Movement legislator Federico Malavassi, who signed the request, told The Tico Times on Monday that Sala IV justices’ feedback about the bill itself is non-binding, but if they agree with the allegations of procedural violations, discussion of the bill must begin again at the point the violation occurred.

Despite the uncertainty posed by this constitutional review, foreigners and Costa Ricans alike have begun examining what the bill could mean for them if it takes effect. Part of the bill replaces the sales tax with a new, broader value-added tax, which would take effect two months after the law’s publication in the official government daily La Gaceta. The section that modifies the income tax system would likely take effect Jan. 1, 2007 (TT, Feb. 17).

President Abel Pacheco, for whom the tax plan’s approval has been the over riding theme in almost all his public statements, expressed his satisfaction at the press conference following his weekly Cabinet meeting Tuesday. He called the next President “lucky” because the ¢200 billion ($400 million) estimated additional revenue from the reformed tax system will decrease poverty within two or three years.

“(He) will carry off the palms, but we’ll carry off the satisfaction,” Pacheco said.

Finance Minister David Fuentes and Central Bank President Francisco de Paula Gutiérrez, who also attended the Cabinet meeting, said the new tax revenue will allow the Central Bank to transfer debts to the ministry, allowing the bank to reduce the amount of colones it emits and resulting in significantly lower inflation.

More Criticism

Malavassi, whose Libertarian Movement Party opposes new taxes and maintains the government should deal with its fiscal problems by improving the collection of existing taxes, alleges violations of legislators’ rights to speak and present motions, as well as irregularities in the rejection of motions proposed to modify the bill.

The legislators who signed the request for review also maintain the bill requires a two-thirds majority (38 votes of 57 total) for approval, not a simple majority (29 votes) as the assembly leadership has decided.

They allege that sections of the bill granting increased rights to authorities to enforce tax collection and track down evaders violate the constitutional right to privacy. Constitutional reforms require the two-thirds majority.

Malavassi said the earliest alleged procedural violations took place in commission –namely, the Finance Commission, which discussed the plan before it reached the assembly floor. If the Sala IV agrees those irregularities occurred, the plan would return to commission.

If justices find no procedural violations occurred, but that the text of the proposed reforms contain constitutional violations, the assembly could ignore these recommendations (leaving the door open for possible Sala IV lawsuits once the law is put into effect), or make the recommended changes in the text, in which case the bill would need to be approved again in first debate.

Finance Minister Fuentes said Tuesday that he is confident the Sala IV decision will be a favorable one for the tax plan.

The tax plan would create what some analysts describe as a modified worldwide tax system. The original draft of the reforms, designed by a group of former finance ministers as a means to provide much-needed revenue to the tax-strapped central government, called for a true worldwide system in which residents are taxed on all income, whether of national or foreign origin.

Over the years, the assembly has modified this aspect of the bill. In the draft of the bill approved last week, any tax resident – defined, for individuals, as anyone who spends more than 183 days per year in Costa Rica or whose primary economic activity takes place here – will pay taxes on any income generated in Costa Rica (as now); income generated elsewhere but brought into the country; or interest on income generated here but invested elsewhere.

Carlos Camacho, president of the tax firm Grupo Camacho, told The Tico Times last week that double taxation could occur under the tax reforms if Costa Rica does not sign tax treaties with major commercial partners such as the United States.

Francisco Fonseca, Director of Taxation for the Finance Ministry, told The Tico Times this week through an e-mail from spokeswoman Rosaura Bermúdez that Israel, South Korea and Switzerland have requested such treaties with Costa Rica, which is launching the preliminary negotiation talks with those countries. A treaty with Spain has already been signed, and Costa Rica’s Foreign Ministry is arranging for it to be placed on the legislative agenda.

Costa Rica and Canada have completed a first round of negotiations for a treaty, but a date for a second round has not yet been set. A treaty with Germany was negotiated but never sent to Costa Rica’s Legislative Assembly because Germany would not agree to renegotiate certain aspects Costa Rica maintains are not favorable to this country.

Costa Rica and the United States signed an Exchange of Information Agreement in 1990 that stipulates the countries will exchange information relative to the calculation, levying and collection of taxes, but according to the Finance Ministry, this agreement does not prevent double taxation.

It’s possible Costa Rica will negotiate an agreement with the United States for that purpose, however.

The corporate tax rate in the new law is 30% – a significant increase from the originally proposed 18% rate (TT, April 16, 2004) – to decrease in 1% increments until reaching 25% in 2010 if the government’s tax revenue grows at a rate higher than that of the gross domestic product.

The value-added tax of 13% on almost all goods and services would replace the current 13% sales tax on a limited number of these, and capital gains, untaxed under the existing system, would be subject to a 10% tax, an important difference for foreign investors. The plan would also create a new Tax Administration, combining the powers that today are divided among the Direct Tax Administration of the Finance Ministry, Customs and the Fiscal Police.


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